A negative interest rate policy (NIRP) is a monetary policy that is used by central banks to keep negative rates in the country. The rates are kept at below zero percent to encourage people to invest and spend money. When a central bank implements NIRP, banks will have to pay a certain sum to the central bank for keeping money in its vault. The banks usually pass on this cost to the consumers as a result of which they avoid keeping their money saved in the bank.
Characteristics of NIRP
Due to lower consumer spending levels, prices of goods fall. As a result, manufacturers are forced to reduce their activities that lead to a slowdown in the economy and an increase in unemployment. NIRP monetary policy is usually applied during such situations to encourage individuals to increase their spending.
When the policy is implemented, consumers usually prefer to invest their money instead of saving it in a bank. Theoretically, this should lead to an increase in prices of goods that will encourage manufacturers to again increase their activities leading to a positive effect on the economy. However, this does not always happen in real world.
Drawbacks of NIRP
NIRP policy is not enough in the event of strong deflationary trends. In order to stimulate the economy, the government also needs to increase its spending on infrastructure projects and create additional jobs.
Another drawback of NIRP is that it encourages banks to lend money more freely to investors without checking their creditworthiness. This will increase the risk of default on loans that will put financial strain on the bank’s profitability.
Lastly, the monetary policy may provide negative effects if the consumers are fearful of investing their money in the market. This may further weaken the economy creating a vicious cycle where the policy makers will be forced to cut rates further to prevent increasing rate of deflation. The only way this policy can be effective when it is complemented with other monetary and fiscal policies with the main intent of creating a positive investment climate that leads to increased economic activity.
Further Reading
- Overcoming the zero bound on interest rate policy – www.jstor.org [PDF]
- Negative nominal interest rates: Three ways to overcome the zero lower bound – www.sciencedirect.com [PDF]
- Financial stability and optimal interest-rate policy – papers.ssrn.com [PDF]
- Repurchase agreements with negative interest rates – papers.ssrn.com [PDF]
- Illiquid banks, financial stability, and interest rate policy – www.journals.uchicago.edu [PDF]
- Interest rate policy and the inflation scare problem: 1979-1992 – papers.ssrn.com [PDF]
- Study on the Effectiveness of China's Interest Rate Policy [J] – en.cnki.com.cn [PDF]
- Balance sheets and exchange rate policy – pubs.aeaweb.org [PDF]
- Innovations in interest rate policy – www.jstor.org [PDF]
